A company's capitalization has a number of important affects on the company’s operations, from securing financing to calculating per-share earnings ratios. In corporations with more sophisticated capital structures, this calculation is complicated by the existence of share options, convertible debt and other financial obligations. In order to calculate the fully diluted capitalization, a company has to take into account all of the outstanding warrants, options and convertible securities that could become common stock.

Capitalization

Capitalization is a way of assessing the value of a company by calculating the total value of issued shares. In a publicly traded company, the market capitalization is calculated by multiplying the total number of shares outstanding by the price per share. Capitalization can also include total long-term financing, including common stock as well as long-term debt, preferred stock and retained earnings.

Possible Sources of Dilution

An owner or investor’s percentage of ownership in a company is generally understood as the percentage of outstanding common stock they own. However, their position can be diluted if the company issues new shares or if other forms of financial obligation are converted into common shares. For example, if a company issues stock options to executives that give the holder the right to purchase common shares, or preferred shares with an option to convert into common shares, these options would be potential sources of dilution for the common shareholders. Similarly, the common-stock shareholder faces dilution if the company has issued convertible debt -- a loan that the lender can choose to change into common shares.

Including Possible Dilution in Capitalization

In determining the fully diluted capitalization of a company, all of the sources of possible dilution must be taken into account. If the company has issued 1,000 shares of common stock, 250 options for single shares of common stock and debt convertible into 750 shares of common stock, the fully diluted capitalization of the company would have to take into account all 2,000 shares when determining the value of the outstanding common stock of the company.

Utility of Fully Diluted Capitalization

Investors in a company are generally interested in their percentage ownership as well as the economic value of their investment. Knowing the fully diluted capitalization allows an investor to see what percentage of the company his investment would be in the event that all of the company’s potential common shares were to be issued, based on its current obligations. Of course, depending upon its formational documents and bylaws, a company can just decide to issue new shares, but this assessment gives the investor a better sense of the real value of their investment in the company.

About the Author

Kevin Doran has been a writer and editor since 2009 whose work has been published in the "Southwestern Journal of International Law." He received a BA in Classics from USC and a JD from Southwestern Law School and is currently pursuing an MA in History at Western New Mexico University.